After receiving reader queries about Banc De Binary, a global company that has been advertising on South African websites, we decided to investigate – what exactly are binary options and who are Banc De Binary?

Andrew Kinsey, head of Product Design and Educational Research at Global Trader provided this information:

Binary Options are very simple financial animals. The payoff to a Binary is either 1 or 0. That payoff is dependent upon a single condition being fulfilled or not. Think of car insurance. Insurance will pay in the event of the car being stolen. Insurance will not pay if the car has not being stolen even though you may prefer the cash at that point.

Example

An asset is trading at a price of 100. A trader has the view that the price of that asset will be higher than 100 an hour from now. In that instance the trader will buy a Binary Call Option (or Up Binary) with a strike at 100. If the market is indeed above 100 after one hour then the trader will receive a payout. If the market is below 100 the trader will receive nothing.

If we were to offer the trader this Binary Option how much should we charge him? Being above or below 100 in one hour seems to be an even money bet. So the fair price is 50. The trader decides that he will commit R2000 to his view. If the market is above 100 in an hour the trader will receive R4000 so his net payoff will be R4000 – R2000 = R2000. He will have doubled his money. If the market is below 100 then the trader will lose his committed R2000.

What is our analysis if the trader has a view on a market being above 120 in an hour when the market is currently trading at 100? That is not an even money bet. Let us give it a probability of 1/3. The trader once again commits R2000 to his view. If the market is above 120 in an hour the trader will receive R6000 so his net payoff will be R6000 – R2000 = R4000. If the market is below 120 then the trader will lose his committed R2000.

If we extend the time over which this trade is alive from one hour to 1 day or even 1 week, how does this affect the price of the 120 binary? The likelihood of the market trading at 120 is enhanced by the increase in time that we have granted so we will charge the trader somewhere between 33% and 50%. The price of the binary is therefore a function of the distance between the current market and the binary strike, and the time to expiry of that option.

The shorter the time to maturity the more speculative the binary bet. The longer the period to maturity the greater the number of potential applications that binary options may offer a trader including hedging existing positions or creating structures that have more complex payoff profiles.

Should you invest through Banc De Binary?

Banc De Binary offer many binaries on a large number of underlying products. This is impressive as is the range of maturity dates. The presentation of the trades is simple and self-explanatory. The issue that I have is with the return that is offered. It really does not represent the potential returns on other platforms, particularly when dealing with longer dated binary options. This would in effect allow BdB to create excess profits by buying or selling hedge products that have a greater payoff profile. Other platforms allow far greater opportunity to construct effective strategies as the returns profiles are far more commensurate with the risk that is assumed. BdB have skewed the game dramatically in their favour and for that reason I would not be a user.